Driving Off the Fiscal Cliff into Taxmageddon
Thoughts on Being a Source of Continuing Revenue
), The Sleeping Giant
Lots of nasty financial events from the past have catchy
nicknames, including the Asian Contagion and the Shanghai
Surprise, Black Friday, the Great Recession. It's always
interesting when an approaching catastrophe gets its own
nickname. I'm thinking of "The Tech Bubble" and "The Housing
Bubble," both of which anticipated the bursting thereof, and
"Y2K," which looked forward to a collapse of the world's
information infrastructure when computers couldn't find a date in
their date counters that maxed out at 1999 and didn't have any
way to enter all four digits of 2000.
Right now, the apocalypse generating the catchy names is the
approach of the Congressionally mandated budget moves called
Taxmageddon or The Fiscal Cliff.
The Fiscal Cliff consists a package of tax increases (allowing
the Bush tax cuts to expire) and spending cuts that will go into
effect in 2013 unless Congress can find a way to agree on a saner
policy. Estimates are that these tax increases and spending cuts
would slice about 4% off the U.S. gross domestic product (
), which would wipe out all growth and kick the U.S. back into a
The conflict at the core of the Taxmageddon scenario is that
Democrats want to reduce the Federal deficit by raising taxes on
the rich, while Republicans want to cut spending. That's a little
oversimplified, but basically accurate.
The two parties are now locked in what has the potential to be an
interesting policy debate about the economic future of the United
States. Unfortunately, it's also a year when we will elect a
president, a new U.S. House of Representatives and about a third
of the U.S. Senate.
Accordingly, following U.S. traditions surrounding election
years, our leaders seem more interested in mouthing platitudes,
demonstrating their ideological orthodoxy and scoring debating
points than they are in actually solving the deficit problem. The
whole Taxmageddon phenomenon is a giant game of chicken, with the
participants apparently quite willing to let the U.S. go over the
Fiscal Cliff as long as they can blame the results on their
opponents. And if they can't get their opponents to blink, they
can at least try to defend themselves from the attacks of their
constituents by citing the (artificial) crisis.
Right now, the stock market is more worried about the possible
fallout from the crisis in Europe than it is about the Federal
deficit. But that will change soon, especially when we get the
election over with and the newly inaugurated president and
leaders of Congress actually have to come to grips with the
Everyone is likely to be disappointed with the result of the
debate, when it finally happens, and that's because extreme
ideological positions are not useful tools for running a country,
just for winning elections.
As always, we at Cabot will manage our growth portfolios with our
usual total disregard for the political campaigns, rhetorical
firestorms and predictions of disaster. The only thing we care
about is what the markets are doing, and we can tell that by
looking at our charts. So neither Taxmageddon nor the Fiscal
Cliff will figure in our stock picks or our buy and sell
If that kind of benign indifference to politics sounds like a
good proposition to you, you can always find a Cabot newsletter
that will fit your investing goals
I admire King Gillette for being the innovator behind the "sell
the razor cheap, then sell them razor blades until the end of
time" idea, but I think disposable blades are too expensive.
Still, because I've actually been shaved with a straight razor
and experienced the excitement of having a stranger wielding a
surgically sharp knife an inch from my carotid artery, I'll take
the multi-blade, pivoting razor cartridges with their little pads
of aloe every time.
But that doesn't mean I have to like being some company's cash
cow. In fact, I'm getting tired of being a source of continuing
Despite my personal feelings, a perpetual revenue stream is the
ideal for lots of great companies. Intuitive Surgical (
), the maker of the revolutionary da Vinci surgical robot, sell
its machines for between $1 million and $2.3 million each, then
supplies all the necessary replaceable parts and single-use
devices for between $100,000 and $170,000 per year. That
certainly puts the cost of shaving cartridges in perspective. But
you can't really object to paying for quality parts and
disposables when a doctor is snipping around your heart (or, even
more critically, your prostate) with scarily sharp robotic
Likewise, Green Mountain Coffee Roasters (
), despite the stock's recent massive correction, can expect a
long run of selling K-cup single-serving coffee pods to a lot of
people who bought its heavily discounted Keurig brewing machines.
Some recurring expenses are just fine. I don't begrudge my pickup
truck its maintenance money for oil changes, tune-ups and tires.
And I'm perfectly happy to feed the devices that demand new
batteries. But those things are just the disposables necessary to
keep my wheels rolling and my flashlight bright.
But now, in my house, there are a humidifier, a bathtub, a
refrigerator, an electric toothbrush, a vacuum cleaner, a
microwave, a lawnmower, a microfiber duster, a mop, a mosquito
repeller and a number of other appliances and tools all with
follow-on purchases built right into their design. And, in
contrast to the old broadcast televisions that delivered programs
to everyone for free, there's a Comcast subscription that brings
television and Internet into my home for only hundreds of dollars
Mind you, I'm not ready to give up any of these goods and
services that nibble away at my money like mice. Lots of them
actually deliver improved performance in exchange for tolerable
investments in disposables. But they all add up, and I'm getting
tired of it.
I'd be glad to hear from you on the topic. Let me know what you
My stock pick today is an old friend that has fallen on hard
times, at least as far as its stock price goes. The company is
, the dominant Internet search engine in China. Roy Ward, the
editor of Cabot Ben Graham Value Report, our value investing
newsletter, recently sent me a memo making the value case for
Roy pointed out that, although BIDU's P/E ratio is a relatively
high 24 times estimated earnings, its price-to-earnings-growth
ratio (PEG ratio) is an attractive 0.70 based on 35% expected EPS
growth during the next five years.
While it's always comforting for a growth investor to get a
concurring opinion from a value guy, I have two independent
reasons for liking BIDU.
First, the revenue and earnings growth history for Baidu is
ridiculously strong. Baidu's revenue growth slowed to 40% in
2009, but rebounded to 81% in 2010 and climbed to 92% in 2011. In
those same three years, earnings grew from 66 cents per share to
$1.55 per share to $3.03 per share. Estimates for 2012 are for
$4.58 per share. The company has eight straight quarters with
after-tax profit margins above 40%.
The knock on BIDU right now is that Chinese search activity is
migrating to mobile devices at an increasing rate, giving
competitors without a big online infrastructure a way to compete
in a new arena. That fear, plus the general concern about slowing
Chinese economic growth, has pulled BIDU from its most-recent
high of 154 to below 110, a dip of almost 30%.
I'm waiting to see what BIDU will do when the Chinese government,
taking advantage of its benign inflation statistics, decides to
use its treasury for a little economic stimulus. The current
Chinese GDP growth rate of "only" 7% is a little lower than
Beijing would like to see. Such a stimulus, plus the intriguing
prospect of Baidu's new tie-up with Apple, would make BIDU an
excellent choice for either a value investor or a growth investor
with a slightly longer time horizon.
Cabot China & Emerging Markets Report